Monday, July 7, 2014

There is no Bankruptcy Protection from Inherited IRAs

There is no Bankruptcy Protection from Inherited IRAs
The U.S. Supreme Court in Clark v. Rameker, 134 S. Ct. 2242, 113 A.F.T.R.2d 2014-2308, 59 Bankr. Ct. Dec. 159 (6/12/2014) has held that inherited IRAs do not qualify for a bankruptcy exemption, and therefore are not protected from creditors in bankruptcy.
Many of us know that assets in an IRA are protected from creditors both under most state laws and in Bankruptcy. Pursuant to 11 U.S.C. 522(b)(3)(C), a debtor may exempt amounts that are both (1) "retirement funds," and (2) exempt from income tax under one of several specified Internal Revenue Code provisions, including Code Sec. 408, which exempts IRAs.
In the Clark case, the daughter of an IRA account holder held an inherited IRA which allows her to keep the assets in the IRA and only take the assets out annually over her life expectancy. They then filed for bankruptcy and sought to keep the inherited IRA from the creditors. There had been a split amongst the circuits: the Seventh and Fifth Circuits were contradictory so the Supreme Court resolved the controversy by unanimous decision (Justice Sotomayor writing for the unanimous court) in favor of the creditors.
She stated that the "text and purpose" of the Bankruptcy Code provided that funds held in inherited IRAs are not "retirement funds" for purposes of the Bankruptcy Code §522(b)(3)(C) exemption.
Left open by the Court is the query of whether assets in a spousal rollover IRA would be factually distinct or might also be subject to creditors.
Recommendation: A trust for the benefit of the beneficiary – rather than naming the beneficiary outright - may avoid the result that the Clarks had in this case.